Ground leases are an essential - if rather unusual - part of the property financing industry. Because they normally cover big costly residential or commercial properties like Rockefeller Center and The Empire State Building, to name 2, and last a long period of time (99 years and up to begin) the likelihood of something unexpected or unintended happening is high. This likelihood increases drastically if, as highlighted below, one or both of the lease celebrations' declare personal bankruptcy. Accordingly, realty experts should take note and take care when participating in any deal including a ground lease.

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Ground leases have been around since the Middle Ages and insolvency laws have existed considering that at least Roman Times. Given this long history, it is not a surprise that a great deal of law has established on the interplay of bankruptcy and ground leases. This is particularly so considering that the development of the "contemporary" United States Bankruptcy Act in 1898 and the substantial changes to title 11 of the United States Code executed to it in 1978, when Chapter 11 of the United States Bankruptcy Code (the "Code") was enacted. [1] In particular, Section 365 of the Code provides special guidelines for the presumption or rejection of a ground lease-as well as its prospective sale and transfer by a debtor to a 3rd party.

Knowing these rules is critical to any real-estate specialist. Here are the essentials:
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A ground lease, often referred to as a "land lease," is a distinctive mechanism for the development of industrial realty, taken pleasure in by those charged with establishing the Rockefeller Center and the Empire State Building, for example. The plan permits prolonged lease terms frequently as much as 99 years (with the alternative of renewal) for the landowner to maintain ownership of the land and collect lease while the developer, in theory, might surpass the land to its benefit as well. Both historically and currently, this irregular relationship in the real estate space creates ample conversation weighing the structure's benefits and drawbacks, which naturally grow more complicated in the face of a ground lessor or ground lessee's personal bankruptcy.

According to a lot of courts, including the Second Circuit, the threshold question in analyzing the abovementioned possibilities regarding a ground lease in insolvency court is whether the ground lease in question is a "real lease" for the function of Section 365. Section 365 uses, making the ground lease eligible for, assumption or rejection, just if it is a "real lease." [2] While just what constitutes a "real lease" will differ state by state, it is extensively accepted that "the appropriate questions for a court in figuring out whether § 365 [] governs an agreement repairing residential or commercial property rights is whether 'the parties planned to impose obligations and confer rights significantly different from those occurring from the common landlord/tenant relationship.'" Intl. Trade Ad. v. Rensselaer Polytechnic, 936 F. 2d 744 (2d Cir. 1991). This "intent" is figured out based upon that of the celebrations at the time of the lease's execution. In re Big Buck Brewery Steakhouse, Bkrptcy No. 04-56761-SWR, Case No. 05-CV-74866 (E.D. Mich. Mar. 9, 2006). Despite there being "a 'strong anticipation that a deed and lease ... are what they claim to be,'" the financial substance of the lease is the primary determination of whether the lease is considered "true" or not, and in some states (like California), is the only suitable element to weigh. Liona Corp., N.V. v. PCH Associates (In re PCH Associates), 804 F. 2d 193 (2d Cir. 1986) pointing out Fox v. Peck Iron & Metal Co., 25 Bankr. 674, 688 (Bankr. S.D. Cal. 1982). Generally, the more away those "economic realities" are from the regular landlord/tenant relationship, the less likely a lease will be considered a "real lease" for the purpose of Section 365. Id. For instance, if residential or commercial property was bought by the lessor particularly for the lessee's use or solely to secure tax benefits, or for a purchase rate unassociated to the land's worth, it is less likely to be a real lease.

If the ground lease remains in reality identified to be a "real lease" (and subject to court approval), the appointed trustee or in an insolvency case might then either assume or decline the lease as it would any other unexpired lease held by the debtor.

However, exceptions apply. These heavily depend on a debtor's "appropriate guarantees" to the staying parties to the agreements. Section 365 of the Code provides that if there has been a default on a debtor's unexpired lease, the DIP may not assume the previously mentioned lease unless, at the time of assumption, the DIP: (i) cures or provides "appropriate guarantee" that they will in fact "without delay cure [] such default"